It is a pleasure to be here to open the 18th Australasian Finance and Banking Conference.

Our national and international financial markets play an increasingly prominent role
in day-to-day life. They are certainly in the news. Not a single television
or radio news bulletin passes without us being informed of the latest daily,
or even intra-daily, movement in the US stock market, the exchange rate, the
price of gold and – probably of more interest to the average person –
the price of crude oil.

I suspect that, to no small extent, this almost obsessive focus on short-term price
movements reflects the need for a high-capacity media to have a large amount
of apparent ‘news’ to convey, even when the quantity of genuine information
is small. The high-frequency nature of financial market trading – a new
piece of ‘news’ every minute – is a natural source of grist for this
particular mill. How useful this actually is, on the other hand, one could
debate.

Likewise, the short-term reporting schedule of corporate and fund management results
is perhaps understandable, viewed from the perspective of accountability in
an era in which trust in management has been weakened. But, at the same time,
it probably exacerbates the natural human tendency toward myopia and impulsive
decision-making by investors, while the attendant pressure on managers to deliver
steadily improving results period by period hardly seems conducive to far-sighted
decisions. It remains to be seen, moreover, what will be the effect on behaviour
of changes to accounting standards which will almost certainly increase the
apparent short-term volatility of corporate results. Some have argued, I think
persuasively, that an undue focus by investors and managers on the short term
is a significant impediment to long-run performance. This seems an issue worthy
of further study. Hopefully, you might spare some time for that at this conference.

In any event, there is no doubt that the functioning of our financial systems is
very important. Once upon a time, when asked what was the role of a financial
system, we might have answered: to match the resources of savers and the needs
of entrepreneurial types, so as to enable the deployment of capital in some
prospectively profitable venture. That (rather 19th-Century-sounding) definition,
with an emphasis on intermediation, is still correct as far as it goes. But
these days, with an increasing proportion of society's capital – even
our infrastructure – held in marketable form, the role of markets in
pricing assets is key. We would add, as well, that the role of a financial
system is to price risk, in ever more finely defined bundles, and to allow
people to adjust their portfolios so as to be exposed to just those risks,
and opportunities, that they desire – no more and no less.

The system's efforts to provide just that set of possibilities has led to a plethora
of sophisticated and increasingly complex products. This development, in turn,
has raised questions by various observers and regulators as to whether those
who have ended up holding certain risks are fully aware of them. Questions
have also been asked of late about the back-office infrastructure supporting
the most complex transactions, and there is a degree of concentration in some
of these markets which could conceivably be problematic under less benign market
conditions.

Nonetheless, these functions beyond pure intermediation seem only likely to grow
further in importance for various reasons, not least among them demographic
trends. As people confront longevity risk, in addition to the usual battery
of market risks, the search will be on for new instruments and practices which
enable this risk to be priced and managed. While it is highly doubtful, in
my view, that ageing can be addressed simply by financial engineering, the
financial system will have a role to play. Its effectiveness and efficiency
in that role will be a focus of discussion in years to come. It's appropriate,
therefore, that some parts of the conference program will be devoted to topics
in the retirement income area.

It is also fitting that the conference has adopted the title ‘Financial Challenges
and Opportunities in the Asia Pacific Region for the 21st Century’. The Asia-Pacific has been, and remains, a source of
economic dynamism – that's the ‘opportunity’ part. But it has also been
a scene of considerable financial turmoil over the past decade – that
is the ‘challenge’ part.

You have had some thoughtful presentations this morning on some of the issues. I
could not do justice to all of them in brief remarks. Allow me to touch briefly
on just a couple of themes.

The first is the potential, and need, for financial development in Asia. It has been
apparent for some time that east Asia's weight in global production of goods
and services is increasing (Japan aside). Non-Japan east Asia, including China,
has seen its share of global GDP almost double, to about 20 per cent,
since 1990. It is likely to rise further in the period ahead. The extent of
merchandise trade within the region has also grown rapidly, as trade barriers
have declined and cross-border component sourcing has increased. So Asia is,
these days, a powerful force in international trade.

Yet, according to many east Asian people themselves, the development of Asia's financial
system has not kept pace. It is not so much the size of the banking systems
which is in mind here – in a number of cases, these are actually quite
large (though there are some important exceptions like Indonesia, or the Philippines).
Rather, it is the depth, resilience to shocks and capacity to intermediate
the region's savings within the region that is at issue.

With the onset of the financial crisis of 1997–98, it was apparent that Asia
was not resilient to disturbances in international capital markets. Foreign
capital had flowed into east Asia – something which made sense then,
and still makes sense now. The exchange rate risk associated with these flows,
however, was being borne mostly in the recipient countries: they had borrowed
foreign currency unhedged. The result of these exposures was that, when exchange
rates moved, the pain was concentrated in banks and/or their customers in Asia,
something which exacerbated the crisis and put policy-makers in an impossible
position. Because of heavy reliance on bank funding, with somewhat under-developed
general capital markets, this was very damaging for a number of regional economies.

Post crisis, still keen on a fair degree of exchange rate stability, but unsure of
the extent of likely support from the international community in the event
of another crisis, the countries of east Asia have opted for greater self insurance
against volatility of international capital flows. This takes the form of vastly
increased holdings of official reserve assets, mainly the US dollar. While
this response has been understandable, some even in Asia have questioned whether
it makes sense for Asia to operate, in effect, as an extension of the US dollar
zone.

Joseph Yam, Chief Executive of the Hong Kong Monetary Authority, laments the
situation in the following terms:

Whether we like it or not, we now find ourselves in the unenviable position of holding
a substantial part of our savings in the financial liabilities of an economy
that does not save, fearing that a diversification of a small part of such
holdings might lead to a sharp fall in the value of the rest, thus shooting
ourselves in the foot. We also find ourselves somewhat stuck with recycling
a large part of our savings through the developed markets back into the region
in a much more volatile form, occasionally creating havoc in our monetary and
financial
systems.[1]

The challenge for Asia then, according to its own financial leaders, is to develop
a financial system which can allocate local savings to local needs more directly,
can be resilient to the risks associated with international capital flows,
and be somewhat less dependent on banks as a funding channel.

This is no small task. Thus far, apart from managing the fall-out from the crisis,
efforts have been made to strengthen banking systems. A good deal of work has
also occurred to improve capital markets, particularly bond markets.

One of the key breakthroughs will be when Asian governments and corporates can borrow
as needed in open markets, in their own currency and at an acceptable price,
leaving any currency risk to others willing to bear it – like foreign
investors. Australian borrowers have been in this happy position for a long
time now, like their counterparts in other advanced economies. For emerging
market countries to enjoy the same opportunity would be a major improvement
on the past.

For this to occur, there needs to be a confluence of high-quality issuers, informed
investors, and well-functioning markets to allow hedging and swaps. As Asian
authorities seek to facilitate the development of these markets by removing
impediments, and the occasional modest official transaction, opportunities
will presumably exist for capable market players in Australasia to play a role.

Opportunities might also lie, perhaps over a longer horizon, in the area of household
finance, since the number of middle-income Asian households is rising quickly,
and their income growth is rapid. It could be anticipated that their demand
for more sophisticated asset and liability products will correspondingly grow.
One would think that Australasian institutions would be well placed, given
the skills acquired in their home markets, to take part in any such development.

A second, not unrelated, theme is the so-called ‘global imbalances’ issue. There
is no time to rehearse all the arguments here, but one simple point can be
made. As the size of capital flows from Asia to the US increased over the past
decade or so, the price – the interest rate – declined. Hence, it would appear that developments on the supply side
of this market were very important in driving the phenomenon. That is a reminder
that if the capital is to flow more slowly to the US, adjustments to Asian
behaviour will be part of the process.

The increased net supply of saving from Asia reflected a sharp decline in corporate
investment in the Asian region (outside of China) after the crisis. At some
point, Asian corporate investment will presumably recover. One would also imagine
that, in some cases, there is a need for upgrades to public infrastructure,
and a case for higher-quality private housing. Hence, in due course, the net
supply of Asian saving to international markets, other things equal, will decline.
Just when that will be, of course, and what other changes might accompany such
developments, no-one can say. But no discussion of the challenges in the Asia-Pacific
region would be complete without some coverage of such issues.

Let me conclude by saying how fitting it is that the conference takes place in Sydney,
one of the Asia-Pacific's major financial centres. As the first largish market
to open in the world trading day and as the financial centre of a medium-sized,
developed economy, Sydney plays a prominent role in the region's financial
trading, even though some other markets are somewhat larger. It is the leading
market for the world's sixth most actively traded currency. Australia's share
of global foreign currency trading, at about 3½ per cent, is higher
than in a number of comparably sized economies, and is about three times Australia's
weight in world GDP. Markets here are sophisticated and liquid, and the participants
innovative. Sydney, and Australia more generally, has much to offer the region
in financial services expertise. That said, participants here would be only
too aware that financial market operations are highly competitive and the local
players need to remain on their toes. So it is good to see some local market
participants thinking about how to contribute to the development of vibrant
markets in the region.

These and other interesting issues will no doubt be covered in the conference, if
they have not already been. I wish you well in your deliberations.

Endnote

Remarks made at the recent Global Bond Summit, Hong Kong. Available at <http://www.hkma.gov.hk/eng/key-information/speech-speakers/jckyam/20051115-1.shtml>
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